Must-knows before selling home to daughter

DEAR BENNY: I own two properties and would like to sell my current residence to my daughter and her husband, and move into the other. Its assessed tax value is about $150,000, but I'd like to sell it to them for about $200,000 interest-free. Both my houses are paid off so I don't need any down payment from them.

Am I required by tax laws to charge them interest? Just thinking how much simpler it would be for me to do my taxes every year if I didn't have to figure out the amortization of the interest on the house I made as part of my income. --Patricia

DEAR PATRICIA: There is no legal requirement to charge interest. However, the IRS calls this "imputed interest." Under the tax code, loans that carry little or no interest are considered "arm's-length transactions." You, as lender, are considered to have made a loan to the borrower at the statutory rate of interest, and this phantom interest is income to you. And in most situations, the borrower has the right to deduct that interest even though it was not actually paid.

My suggestion: Every month, the IRS publishes what it known as the "applicable federal rate" (AFR). Check with your tax adviser to find the lowest legal rate you can charge your daughter.

I assume that you want your daughter to be able to take tax deductions on the loan, so make sure that there is a document entitled "deed of trust" or (depending on where you live) "mortgage" and that the document is properly recorded among the land records in the county where the property is located.

If there is no such recorded document, the borrower cannot take advantage of the interest deduction.

You should consult with an attorney to assist you in the entire process.

DEAR BENNY: I used to own a time share in Kitty Hawk, N.C. Last year I decided to default on the maintenance fees, as we were no longer going to use it. In California, when one defaults, the trustee forecloses. I am not sure what the case in North Carolina is.

I tried to find a buyer but had no response until my stepson agreed to take title subject to the lien of maintenance fees, which he never paid. The time-share people told me they will not recognize the transfer until the maintenance fees are current, even though it is a matter of record.

I could not find anything about that in my agreement, however, and I am not privy to the declarations of record, which may substantiate their refusal to transfer ownership. Just wondering what my position is at this time. --Chester

DEAR CHESTER: Generally, throughout the nation, when a homeowner (or a time-share owner) defaults, there will be a foreclosure. Of course, the exact procedure is dictated by (1) the applicable state law and (2) the legal documents that the homeowner initially signed.

As an owner (albeit in default) I believe you have the absolute right to view the declaration. However, I suspect that the time-share people are refusing to allow the transfer to your stepson based on the documents you signed.

Generally, in most real estate promissory notes and deeds of trusts (sometimes called a "mortgage") there is a "due on sale" clause. This means that if the property is transferred to a third party, the entire balance becomes "due on sale."

There are some exceptions, but your situation does not fall within the exceptions.

What should you do? Does your stepson really want that time share? If so, he should try to negotiate a payment plan (or pay it all off). Otherwise, you have no alternative; let it go in default and ultimately the time-share company will decide to foreclose.

However, in many states, the law does not prohibit default judgments. For example, you owe $100,000 but the foreclosure brings only $70,000. That means that the foreclosing party can go after you for the $30,000 difference. Talk to your own lawyer about the laws in your state. I suspect, however, that even though you live in California, the laws of North Carolina will apply because the property is located there.

DEAR BENNY: How do you go about replacing the deed of trust note if you don't have the original note? The deed is recorded. --Jim

DEAR JIM: That's the billion-dollar question that banks, lawyers, judges and the government have been wrestling with since the mortgage meltdown began. When lenders started to sell (called "securitization") their mortgage documents, many of the legal documents -- especially the promissory note -- were lost in the shuffle.

And many judges, when dealing with foreclosure cases, take the position that if a lender cannot produce the original promissory note, it cannot foreclose. But that's another story.

When you borrow money to buy a house, you sign two important legal documents: (1) a promissory note (I/we owe you Bank XX dollars, payable in so many years at YY percent per year); and (2) a deed of trust (in some states it is still called a mortgage).

The deed of trust conveys your property in trust to a trustee, selected by the lender. If you pay the mortgage off in full, the trustee will release the document from land records; however, if you are in default, the deed of trust gives the trustee the "power of sale," which is the authority to sell the property at a foreclosure sale.

When you obtained your mortgage loan, you signed both documents. The original promissory note was delivered to the lender; the original deed of trust was recorded among land records in the county where your property is located, and then returned to the lender.

You should have received a copy of both documents from the settlement or title attorney (or escrow company) where you signed those documents.

So, if you are the borrower, the first place to go for the note is where you originally signed. However, you will not get the original note until it is paid off in full.

If you are the lender asking how you can replace the original note that is now lost, I suggest you discuss the matter with your local counsel. Some states have enacted legislation allowing a lender to use a copy of the note as an original if the lender complies with certain requirements imposed by the law.

DEAR BENNY: I am 57 years old and have a mortgage remaining on my house of $45,800 at 4.875 percent interest and a home equity loan of $41,000 with a variable rate. The assessed value of the home is $250,000. I am able to pay more than the minimum payments on both loans every month. Which should I pay more on? --Margaret

DEAR MARGARET: Your home equity loan (lenders call them a HELOC for "home equity line of credit") has a variable interest rate. Right now, I suspect it is very low. But, over time, I also suspect that it will start creeping up.

My first suggestion is to refinance and get a brand-new loan. Currently, interest rates are at all-time lows. Your two loans total $86,800; that means you have plenty of equity. While it is true that getting a loan (refinance or purchase) is very difficult in today's marketplace, if your credit is good, I suspect that lenders will be happy to make you a new loan. Because of the equity in your house, their risk is very low.

If you can get a new loan, you might want to consider making larger payments every month. Although a 15-year loan carries a lower interest rate, I am not a fan of those loans. Why?

With a 15-year loan the monthly payment is much higher and you are obligated to make that payment each and every month. With a 30-year loan, you have the option (not the obligation) to send in larger payments every month, even as large as you would have been required to pay with that 15-year loan.

Keep in mind that, with a 30-year loan, if you make one extra monthly payment a year, whether spread out over 12 months or in one lump sum, you will significantly reduce the length of the loan. In some cases, it could be as low as down to 22 years, instead of 30.

If, on the other hand, you cannot (or don't want to) refinance, I would analyze both loans. If the HELOC currently has a lower interest rate than the 4.875 first mortgage, you may want to start making larger payments on the first mortgage. Then, if the variable rate becomes higher, switch your extra payments to the HELOC.

There is no obligation to stick to one loan; you have the right to (1) make larger monthly payments on both loans; (2) make larger payments on either one of the two loans; (3) alternate making the larger payments as you so choose; or (4) not make any extra payments at all.

You should, however, read your legal documents to make sure that you can make extra payments. Rarely have I seen any restrictions on loans made by commercial banks. However, if your lender is a private entity such as a pension plan or a trust, there may be restrictions on how much extra money you can pay monthly.

Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.